Presentation to Minneapolis Fed's Advisory Council on Small Business, Agriculture and Labor

Three times annually, the Minneapolis Fed's Advisory Council
on Small Business, Agriculture and Labor meets with President Gary
Stern and bank staff to report on the state of the Ninth District's
economy. The Minneapolis Fed's Advisory Council, similar to others
formed in 1985 at each of the 12 Federal Reserve district banks, consists
of 12 members serving three-year terms. Advisers are selected to represent
geographic, economic and gender/racial sectors in the Ninth District.

Just as the national debate over health care reform has intensified
in recent months, so has concern about the issue grown within the Minneapolis
Fed's Advisory Council on Small Business, Agriculture and Labor. At
its February meeting, the council heard a presentation outlining the
causes of America's health care ills and suggesting a plan for reform.

John Kralewski, director of the Division of Health Services Research
and Policy at the University of Minnesota's School of Public Health,
who made the presentation before the council, said he is encouraged
by the growing awareness of health care issues. He said he hopes
that people's concern will soon translate into serious reform.

However, Kralewski told the advisers that for those who are waiting
for government to provide a remedy, a federal solution to the problem
is unlikelyat least within the next few years. The best chance
for major reform is at the state level, he said.

Problem: uncontrollable costs

That there are major problems with the health care industry is evident:
Health costs are rising at a 16 percent to 18 percent rate in recent
years, Kralewski said, at a time when the consumer price index has
hovered at about 3 percent to 4 percent. Consumers, businesses and
all levels of government are in some way adversely impacted by these
spiralling costs, he said. For example, on average, U.S. companies
spent an amount equal to 26 percent of their net income on health
care in 1990. In Minnesota, Edina- based Regis Corp. plans to drop
its employee health insurance plan as of April 30 because of excessive
cost. Regis employs about 14,000 at 1,000 hairstyling salons throughout
the country, but less than 10 percent of those employees were reportedly
enrolled in the plan.

There are many reasons for the increased costs, according to Kralewski,
but he listed the following:

America's aging populationmore and more money is spent
on one sector of the population that continues to grow;

Rapid advances in technologytransplants have become so
pervasive and are so expensive, for example, that "the only thing
that's keeping the system from going completely broke is a lack
of donors," he said;

Uncontrolled use of newer and more expensive proceduresthere
are approximately 40 CT scan machines in the Minneapolis/St. Paul
metro area, a comparable Canadian city has two;

Fee-for-service payment systemstudies show that when
physicians require extra income they order more services for their
patients.

The fallout from this price explosion is that insurance costs are increasing,
employers are shifting more insurance costs to employees, some employees
are paying more money for less services than before, the ranks of the
uninsured continue to grow and some government medical programslike
Medicaid in some statesare simply going broke, Kralewski said.

For some states, the Medicaid crunch has led to major changes
in operation. Oregon, for example, has enacted a controversial plan
that limits the types of medical services available to Medicaid
recipients. If a medical procedure is not on the state's list of
approved services, the treatment is not paid for by Medicaid, regardless
of the consequences.

Solution: pooling plus competition

But rather than control costs by placing limits on services, Kralewski
offers some ideas for health reform that try to reduce costs through
competitive forces. He told the advisers of a state-based health
plan that would provide routine office care from a pool of physicians
on a fee-for- service basis, with advanced care provided by physicians
who would make competitive bids for the state's business.

Kralewski said such a plan would not only reduce the costs of
providing health care, but would also provide coverage to all citizens.
Under such a plan, participants would pay a $10 fee per visit to
a primary physician, but all specialized care would be paid through
the health plan. The financing for such a plan would come from taxes
and employer contributions, in addition to payments by users (depending
on ability to pay).

The advantage of gathering thousands of residents into one large
pool is that the state would then have tremendous bargaining power
with physicians, according to Kralewski. Physicians who wanted the
business of the state's pool would not only have to provide a competitive
price, but would also have to provide quality service in order to
be considered, he said. Additionally, if physicians are forced to
perform more procedures at a cheaper price in order to recover the
income they previously would have earned, Kralewski said they will
then become even more proficient. Studies show that, in general,
the best physicians are those who perform procedures more frequently,
he said.

Any reform plan must also attempt to control costs by bringing
together overlapping resources within a community and housing them
in a central place, like x-ray and laboratory services, nursing
personnel and administrative capabilities. In rural areas, for example,
that may mean that all health officeslike private doctors'
offices and clinicsshould be housed in a central unit like
a hospital.

Kralewski said that if an effective state-based plan was enacted,
it could expect to reduce the rate of cost increase by 20 percent
to 30 percent. And the most important element of any plan to reduce
health costs has to focus on the physician, he said, because physicians,
and not consumers, are the ones who order health services. He also
advised employers to pool their employeesmuch like a state
health planthen bid out for health services, rather than allowing
employees to pick and choose any physicians they wish.

One issue Kralewski didn't specifically address was the health
care component of the workers' compensation system, which, according
to Bernard Brommer, president of the Minnesota AFL-CIO, is a rapidly
escalating element in health care costs. The workers' compensation
system requires total coverage for health care costs due to workplace
injuries without deductibles and co-payments, he said, and also
because there is also litigation in workers' compensation cases,
there is the potential for medical care providers to enhance utilization
and charges for workers' compensation care.

Workers' compensation and health insurance proposals have been
at the forefront of recent legislative sessions in Minnesota. And
Brommer said health care issues have been and will continue to be
a significant cause of friction in collective bargaining relations
between labor and managementin Minnesota and across the country.
"Financial resources to create new jobs or buy new equipment are
being used to pay for increases in health care," he said.

Kay Fredericks, president and CEO of Trend Enterprises in New
Brighton, Minn., said her company's employees used health care services
more carefully after the company adopted a small co-payment for
each visit to a doctor. She said that employees and employers would
both benefit if consumers would become more informed about their
health care options and would regularly question their doctors about
the needs and risks of certain procedures. Kralewski agreed with
the need to educateand thereby empowerconsumers of health
care, including employers: "All I do when I get a pain is present
myself and someone else spends the money."

Some of the advisers had questions and concerns about the economic
health of small-town hospitals. In Ashland, Wis., a town of 9,000
in the northern part of the state, the local 100-bed hospital is
operating successfully, according to Tad Bretting, president and
CEO of C.G. Bretting Manufacturing. He said the key to the hospital's
success is that the hospital has a committed staff that is willing
to work for less money as long as the hospital supplies the staff
with top-notch equipment.

Small hospitals also have to be mindful of cost control and revenue
collection, according to Susanne Boxer, president and CEO of Houghton
National Bank in the Upper Peninsula of Michigan. She said she served
on the board of a not-for-profit hospital owned and operated by
the Sisters of St. Joseph. The hospital was sold to a group of community
leaders because the Sisters' commitment to serve the community's
health care needs was not matched by an equal commitment to collect
payment for their services.

Harold Gershman, president of Happy Harry's Bottle Shop in Grand
Forks, N.D., said that Grand Forks' United Hospital is establishing
a referral relationship with neighboring rural hospitals whereby
those hospitals send patients who need specialized care to United.